Banking Alert! ECB’s New AQR Methodology

The ECB’s updated Asset Quality Review (AQR) Manual and related tools are already used for the new SSM banks and for the on-site inspection missions and will be soon used in countries outside the eurozone to increase financial system credibility. The changes in the Manual are made in order to accommodate new regulatory requirements (IFRS 9 and MiFID II) and to better capture the specifics of investment services firms.

The IFRS 9 implementation kept all financial institution’s attention in the last few years and is still expected to be a topic of interest in the following years until it reaches high quality and consistent implementation. ECB’s challenger model will generate benchmark results which will be the starting point in the supervisory dialogue. Banks will have to demonstrate that their provision level is appropriate and provide plausible well-evidenced reasons for the differences. Financial institutions should timely prepare a solid validation framework and should achieve sound understanding of the IFRS 9 internal model and the ECB’s challenger model.

MiFID II took seven years from consultation to implementation and generated 30,000 pages of rules; the AQR review will look into conduct risk framework, conduct top risk identification and controls and provisioning for conduct losses in order to identify conduct-related issues as a key source of risk to capital.

To help financial institutions be proactive and prepare for the upcoming on-site inspection missions and on the AQR exercise, we have explored the key changes and challenges of the new ECB Manual and we propose a structured planned approach.